Retirement Savings Options when You Are Self-Employed
When you are self-employed, you don't have a 401(k) plan with contributions from an employer to help you save for retirement. You need to take your retirement savings into your own hands, and you have several options.
Social security
When you are self-employed you continue to earn credits toward social security benefits and you continue to pay the equivalent Social Security and Medicare taxes through the self-employment tax. This tax is reported on Schedule SE when you file your annual income tax return. You should take this self-employment tax into account, along with your projected federal income tax liability when you determine the estimated payments you make during the year.
The social security portion of the self-employment tax applies on the first $106,800 (for 2011) of net earnings from self-employment. The Medicare portion of the tax applies on all your net earnings. The 2010 Tax Relief Act reduced the self-employment tax by 2% for 2011 to 13.3%. 10.4% applies to Social Security and 2.9% to Medicare. The normal rate is 15.3%, with 12.4% for Social Security and 2.9% for Medicare. You can deduct half of your self-employment tax for purposes of calculating your net income subject to federal income tax.
Traditional or Roth IRA
If you are self-employed as an independent contractor or you operate a sole proprietorship with no employees, you could save for retirement through a traditional or Roth IRA. There are various differences between these types of IRAs, but one of the principal differences is taxation. With a traditional IRA you can claim an income tax deduction for your contributions up to a certain amount per year, and the distributions you take from the IRA when you retire are subject to income tax. With a Roth IRA you cannot claim a tax deduction for your contributions, but the distributions you take when you retire are not subject to income tax.
Individual 401(k)
Another option if you work alone is the individual 401(k). One of the advantages of an individual 401(k) is that you could potentially put away more money for retirement. You can contribute as the employee and also as employer. Your spouse can also contribute, and if you are over 50 years old, you can make catch-up contributions. But as pointed out by the IRS, individual 401(k) plans are no different from other 401(k) plans, other than that they have only one participant. If your business adds employees in the future, they would have to be included in the 401(k) plan.
Small business retirement plans
If your small business has employees, you could set up a Simplified Employee Pension, or SEP Plan. Under this type of retirement plan, individual IRAs are set up for you and your employees. You must contribute a uniform percentage of pay to each employee, but you can decide how much to contribute each year, which gives you some flexibility.
Another option for small businesses is a SIMPLE plan. A SIMPLE plan can be a SIMPLE IRA or a SIMPLE 401(k) plan.
There are differences, but under both types of SIMPLE plans, you as the employer are required to contribute to the IRAs or 401(k)s set up for you and your employees. You must match the employees' contributions up to 3% of their compensation or make at least a 2% contribution if an employee does not contribute.
More information
You can find a comparison of the different retirement plan options for small business in the IRS publication Choosing a Retirement Solution for Your Small Business. IRS Publication 560, Retirement Plans for Small Business provides more detailed information. For more information on specific types of small business retirement plans, you could see 401(k) Plans for Small Business, SEP Retirement Plans for Small Business, and SIMPLE IRA Plans for Small Business.
Sources:
401(k) Plans for Self-Employed Individuals Fact? Or Fiction?, IRS
401(k) Plans for Small Business, U.S. Department of Labor and the IRS
Choosing a Retirement Solution for Your Small Business, IRS
Publication 560, Retirement Plans for Small Business, IRS
Publication 590, Individual Retirement Arrangements (IRAs), IRS
Schedule SE, Self-Employment Tax, IRS
Self-Employment Tax (Social Security and Medicare Taxes), IRS
SEP Retirement Plans for Small Business, U.S. Department of Labor and the IRS
SIMPLE IRA Plans for Small Business, U.S. Department of Labor and the IRS
Social security
When you are self-employed you continue to earn credits toward social security benefits and you continue to pay the equivalent Social Security and Medicare taxes through the self-employment tax. This tax is reported on Schedule SE when you file your annual income tax return. You should take this self-employment tax into account, along with your projected federal income tax liability when you determine the estimated payments you make during the year.
The social security portion of the self-employment tax applies on the first $106,800 (for 2011) of net earnings from self-employment. The Medicare portion of the tax applies on all your net earnings. The 2010 Tax Relief Act reduced the self-employment tax by 2% for 2011 to 13.3%. 10.4% applies to Social Security and 2.9% to Medicare. The normal rate is 15.3%, with 12.4% for Social Security and 2.9% for Medicare. You can deduct half of your self-employment tax for purposes of calculating your net income subject to federal income tax.
Traditional or Roth IRA
If you are self-employed as an independent contractor or you operate a sole proprietorship with no employees, you could save for retirement through a traditional or Roth IRA. There are various differences between these types of IRAs, but one of the principal differences is taxation. With a traditional IRA you can claim an income tax deduction for your contributions up to a certain amount per year, and the distributions you take from the IRA when you retire are subject to income tax. With a Roth IRA you cannot claim a tax deduction for your contributions, but the distributions you take when you retire are not subject to income tax.
Individual 401(k)
Another option if you work alone is the individual 401(k). One of the advantages of an individual 401(k) is that you could potentially put away more money for retirement. You can contribute as the employee and also as employer. Your spouse can also contribute, and if you are over 50 years old, you can make catch-up contributions. But as pointed out by the IRS, individual 401(k) plans are no different from other 401(k) plans, other than that they have only one participant. If your business adds employees in the future, they would have to be included in the 401(k) plan.
Small business retirement plans
If your small business has employees, you could set up a Simplified Employee Pension, or SEP Plan. Under this type of retirement plan, individual IRAs are set up for you and your employees. You must contribute a uniform percentage of pay to each employee, but you can decide how much to contribute each year, which gives you some flexibility.
Another option for small businesses is a SIMPLE plan. A SIMPLE plan can be a SIMPLE IRA or a SIMPLE 401(k) plan.
There are differences, but under both types of SIMPLE plans, you as the employer are required to contribute to the IRAs or 401(k)s set up for you and your employees. You must match the employees' contributions up to 3% of their compensation or make at least a 2% contribution if an employee does not contribute.
More information
You can find a comparison of the different retirement plan options for small business in the IRS publication Choosing a Retirement Solution for Your Small Business. IRS Publication 560, Retirement Plans for Small Business provides more detailed information. For more information on specific types of small business retirement plans, you could see 401(k) Plans for Small Business, SEP Retirement Plans for Small Business, and SIMPLE IRA Plans for Small Business.
Sources:
401(k) Plans for Self-Employed Individuals Fact? Or Fiction?, IRS
401(k) Plans for Small Business, U.S. Department of Labor and the IRS
Choosing a Retirement Solution for Your Small Business, IRS
Publication 560, Retirement Plans for Small Business, IRS
Publication 590, Individual Retirement Arrangements (IRAs), IRS
Schedule SE, Self-Employment Tax, IRS
Self-Employment Tax (Social Security and Medicare Taxes), IRS
SEP Retirement Plans for Small Business, U.S. Department of Labor and the IRS
SIMPLE IRA Plans for Small Business, U.S. Department of Labor and the IRS
Published by Kevin Hagen
Born in Minnesota, USA in 1955; studied Business Administration - Accounting, graduating in 1977 and obtaining CPA license. Worked in corporate accounting environments, eventually becoming a technical trans... View profile
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